Relative Strength Index (RSI) – Introduction and a Basic Misconception

Developed by J. Wells Wilder and introduced in his 1978 book, “New Concepts in Technical Trading Systems”, the Relative Strength Index (RSI) has become a very popular oscillator and useful momentum oscillator. The RSI compares a trading instrument’s magnitude of recent gains against its magnitude of recent losses and quantifies this information into a value that ranges between 0 and 100. We are taught early that the RSI and other oscillators give us overbought and oversold signals. Specifically for the RSI, a reading over 70 represents overbought conditions, while a reading bel0w represents oversold conditions. When an instrument is overbought it is suggested a sell is in order, and when it is oversold, a buy is in order.

While its true that these levels represent OS/OB conditions, they do not necessarily suggest reversal. In many cases you will find a small, insignificant pause as the RSI resolves the OS/OB conditions, returning back below 70 or above 30. The trend will then continue as the RSI extends even further away from the middle. Therefore the signal could be a near-term signal, but could could be a trending signal in the intermediate term. A break above 70 can suggest a bullish momentum breakout, while a break below 30 suggests a bearish momentum breakout.

Here is a quick video clip on the basic interpretations of the RSI and the misconceptions.

Next: Bullish and Bearish Divergences

Fan Yang CMT
Chief Technical Strategist
FXTimes

Information and opinions contained in this report are for educational purposes only and do not constitute an investment advice. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness. FXTimes will not accept liability for any loss of profit or damage which may arise directly, indirectly or consequently from use of or reliance on the trading set-ups or any accompanying chart analysis.